In their recent shift toward retail deposits, one factor that has helped banks is weak competition from money market funds.

When short-term interest rates are low, such investment vehicles have struggled to offer higher yields than are available for insured deposits, and they have bled funds (see chart).

Between September 2008 and February of this year, retail money market funds contracted by 25%, to $785 billion, according to data from the Federal Reserve. Meanwhile, savings deposits, including money market deposit accounts, rose 22%, to $4.9 trillion.

Money market deposit accounts explain much of the $475 billion (6.6%) increase in domestic deposits since the third quarter of 2008 to $9.2 trillion at the end of 2009, according to data from the Federal Deposit Insurance Corp. (The central bank cut the target for the federal funds rate three times in the fourth quarter of 2008 and ultimately lowered it to the range of 0% to 0.25% where it still stands.)

They increased $483 billion, or 17.3%, to $3.3 trillion during the same period. Other savings accounts and transaction accounts also rose at a good clip, while time deposits, subject to similar rate dynamics as money market funds, fell $408 billion, or 14.7%, to $2.4 trillion.

Cash flowed out of money market funds for about three years amid low rates during the early part of this decade, while money market deposit accounts continued to receive inflows. Later, when rates rose, money market funds grew while increases in deposits were subdued.

But with the Fed committed to low rates for an extended period, the return of such an environment could be many months off.


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